Incorporating Considerations for Franchisees
Many prospective franchisees will consider the question of whether or not to incorporate for the purpose of operating their new franchise. Planning ahead, understanding what incorporating means and your ability to incorporate should be one of the topics contemplated before you enter into a franchise agreement.
Corporations are legally considered to have a separate identity from individuals. Like an individual, they have the power through their agents (directors, officers and employees) to enter into legal obligations. Typically your liability as a shareholder in a corporation is limited to the value of your investment where as a sole proprietor all of your personal assets are available to creditors.
Incorporating also allows you to tax plan in a manner to reduce personal income taxes through options such as paying yourself a wage as an employee or paying out dividends to the shareholders who may be family members.
Ideally, that would be where the analysis would end, however, a review of the franchise agreement will often lead to the discovery that there are ways around the protection a corporation offers. Franchisors often require that a new franchisee sign the franchise agreement in their personal capacity and then assign the agreement to a corporation. As part of the assignment the individual signatories are to remain liable for the obligations of their corporation under the franchise agreement.
Other franchisors will allow a new franchisee to enter into the franchise agreement through a corporation but then require a personal guarantee from the principal shareholders bypassing the protection of the corporation. Lenders, landlords and suppliers will often require personal guarantees as well given the lack of credit history of a newly incorporated business.
In addition, franchise agreements will typically consider a change in shareholders or corporate control of a corporate franchisee a sale of the franchise thereby initiating the requirement of a transfer fee.
Directors and officers also are potentially liable in law for failing to manage their corporation properly.
Directors have a duty to inform themselves of the operations of their corporation. Failure to do so, for example by a spouse who has been named a director for income splitting purposes, is not a defense to liability for unpaid employee wages, pensions, insurance premiums, income taxes, payroll deductions, GST, provincial sales taxes, environmental liabilities or worker’s health and safety.
Further, directors can be held liable for paying out dividends to shareholders over obligations to creditors. Keep in mind that what is good for you as a shareholder many not be good for your corporation which you as a director have agreed to operate in its interest. The level of liability can be managed by proper control and management of the corporation. Director’s and office’s insurance is also available but may be considered costly for a start-up business which will have to also deal with the costs of the initial incorporation and ongoing requirements for record keeping, annual filings, meetings and fees.
In the end incorporating can be a valuable tool for a new franchisee but before taking the step of incorporating consult your legal and accounting expert.
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